Debt

Why Iceland President's Left-Wing Critique Is Right

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Baldr being killed by his blind brother Höðr in a comic misunderstanding.

You wouldn't expect much from an article that starts with this deadly lead sentence: "The president of Iceland sits in his study drinking tea from an immaculate china set." 

But Adam Taylor's Business Insider interview with Ólafur Ragnar Grímsson (Iceland's consitutionally weak president) is a pretty good lesson in why the tiny island nation is recovering while the rest of Europe is falling apart: 

A key example of this approach is Iceland's refusal to pump money into failed banks. The decision was controversial at the time, but now looks increasingly wise. "I have never understood the argument — why a private bank or financial fund is somehow better for the well being and future of the economy than the industrial sector, the IT sector, the creative sector, or the manufacturing sector".

There is, of course, another aspect. A tricky situation arose when the U.K. and Holland demanded money for their citizens' depleted Icesave accounts, and Iceland refused. The incident sparked a major diplomatic scuffle, with Iceland refusing to pay out and the U.K. even using "anti-terrorism legislation" against the state.

Grímsson affects modesty in describing his position, but in fact he's overstating the élites' contribution to the recovery. At the height of the crisis, Iceland tried to make all the same Bernankeist mistakes as the other western countries, but it was unable to do so thanks to its marginal position in the global economy. As described by yours truly in this Reason classic:

Iceland's central bank tried desperately to control the króna's collapse before giving up. Nevertheless, [Iris] Erlingsdottir is right: The "grownups"—a center-left coalition led by Social Democrat Johanna Sigurdardottir—are back in charge and have done their best to double down on the bad policies of the past, including reducing fish quotas when local fishermen most need to be producing and selling. The government is also, in the face of strong popular opposition, moving toward E.U. membership, which has worked out so beautifully for other troubled European economies.

So what's causing the recovery? The plain-sight answer is the one nobody will consider. Iceland is coming back specifically because its banks went out of business. That happened in spite of strenuous public efforts, but the removal of the tiny nation's colossally bloated financial sector turns out not to have eliminated all that much value. 

It bears repeating that banks are not creators of wealth. They are places where you store the surplus value generated by productive enterprise. In very narrow circumstances that surplus value can be loaned out at a profit, but a financial sector is the icing, not the cake. This should be common sense, but apparently it is wisdom so rare it can only be learned in countries small and remote enough to avoid the deadly medicine of the global financial markets. 

Taylor and the president couch their discussion in anti-privatization, pro-regulation good-governmentese, but the reality is that it was withdrawing from the international system of wise-man management that saved the country's economy: 

Ólafur [says] that his problem isn't Europe, but the European and American banking system. He says Iceland's lesson is that "If you want your economy to excel in the 21st century […] a big banking sector, even a very successful banking sector, is bad news."

"You could even argue that the bigger the banking sector is, the worse the news is for your economy," he adds, later blaming the huge growth of Iceland's banking sector on the prevailing European banking philosophy and incompetent rating agencies.

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